Perspectives

FASB clarifies the accounting for share-based payments issued as sales incentives to customers

On November 11, 2019, the FASB issued ASU 2019-08, which clarifies the accounting for share-based payments issued as consideration payable to a customer in accordance with ASC 606. Under the ASU, entities apply the guidance in ASC 718 to measure and classify sharebased payments issued to a customer that are not in exchange for a distinct good or service (i.e., share-based sales incentives).

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Background

In June 2018, the FASB issued ASU 2018-07, which supersedes ASC 505-50 and expands the scope of ASC 718 to include share-based payment arrangements related to the acquisition of goods and services from nonemployees. ASU 2018-07 also amends the guidance in ASC 606-10-32-25 on consideration payable to a customer to expand the scope of the form of consideration to include equity instruments granted in conjunction with the sale of goods or services. Accordingly, under ASU 2018-07, share-based sales incentives are outside the scope of ASC 718 and must be accounted for under ASC 606. While ASC 606 addresses how to recognize share-based sales incentives (i.e., as a reduction of revenue), it does not provide guidance on the measurement (or measurement date) of such incentives. Therefore, upon adoption of ASU 2018-07, there is no guidance that addresses the measurement of sharebased sales incentives.

Volume 26, Issue 22 | November 13, 2019

Key Provisions of ASU 2019-08

Under ASU 2019-08, entities apply the guidance in ASC 718 to measure and classify share-based sales incentives. Accordingly, they use a fair-value-based measure to calculate such incentives on the grant date, which is the date on which the grantor (the entity) and the grantee (the customer) reach a mutual understanding of the key terms and conditions of the share-based consideration. The result is reflected as a reduction of revenue in accordance with the guidance in ASC 606 on consideration payable to a customer. After initial recognition, the measurement and classification of the share-based sales incentives continues to be subject to ASC 718 unless (1) the award is subsequently modified when vested and (2) the grantee is no longer a customer.

Scope

ASU 2019-08 applies to share-based payments granted in conjunction with the sale of goods and services to a customer that are not in exchange for a distinct good or service. As noted above, entities apply ASC 718 only to measure and classify share-based sales incentives, and they reflect the measurement of such incentives as a reduction of the transaction price and recognize it in accordance with the guidance in ASC 606 on consideration payable to a customer. Entities that receive distinct goods or services from a customer should account for the share-based payment in the same manner as they account for other purchases from suppliers (i.e., by applying the guidance in ASC 718). Any excess of the fair-value-based measure of the share-based payment award over the fair value of the distinct goods or services received should be reflected as a reduction to the transaction price and recognized in accordance with the guidance in ASC 606 on consideration payable to a customer.

Connecting the Dots

The ASU’s amendments apply to share-based sales incentives issued to customers under ASC 606 and therefore do not directly address similar equity-based incentives issued by a lessor to a lessee under ASC 840 or ASC 842.

Initial Measurement

The ASU clarifies that share-based sales incentives are reflected as a reduction in the transaction price on the basis of the grant-date fair-value-based measure in accordance with ASC 718 (for both equity- and liability-classified awards). In addition, share-based sales incentives may contain vesting conditions (i.e., service or performance conditions that must be satisfied for the customer to vest in an award) or conditions that affect factors other than the vesting of an award (i.e., market conditions, service or performance conditions that affect factors other than vesting or exercisability, or “other” conditions that do not meet the definition of a service, performance, or market condition). Under the ASU, both vesting and nonvesting conditions should be evaluated in accordance with ASC 718, which specifies that vesting conditions, unlike nonvesting conditions, are not directly factored into the fair-value-based measure of the award. Therefore, the amount recognized as a share-based sales incentive would (1) reflect the actual outcome of any vesting condition and (2) incorporate in its measurement any nonvesting conditions.

Connecting the Dots

Under ASU 2019-08, an entity is required to use judgment when determining whether a vesting condition related to a share-based sales incentive is a service condition or a performance condition.

The recognition of a share-based sales incentive with a service condition that affects vesting will depend on the entity’s accounting policy for forfeitures of nonemployee share-based payment awards. For example, if the entity elects to estimate forfeitures, it bases its estimate of the share-based sales incentive on the probable outcome for both service and performance conditions. However, if the entity elects to recognize forfeitures when they occur, it reflects the entire share-based sales incentive with a service condition that affects vesting in the transaction price unless the award is forfeited.

Many share-based sales incentives include conditions that are tied to customer purchase levels (or to a customer’s remaining purchases for a specified period). We believe that such conditions are akin to service conditions.

While vesting and nonvesting conditions are not subject to the variable consideration guidance in ASC 606, such guidance could still be applicable in certain circumstances. For example, an entity should apply ASC 606-10-32-7 and estimate the fair-value-based measure of an equity instrument before the grant date when a grant date has not been established but (1) the customer has a valid expectation that a share-based sales incentive will be issued (e.g., because of an entity’s history of issuing share-based sales incentives or its ongoing negotiations related to the issuance of a share-based sales incentive for which the terms of the equity instruments have not yet been finalized) or (2) other facts and circumstances indicate that the entity intends to issue a share-based sales incentive. In the period in which a grant date is established, the entity adjusts the transaction price for the cumulative effect of calculating the fair-value-based measure on the grant date. This treatment is similar to the accounting applied when the service inception date precedes the grant date for employee awards.5 For example, an entity could enter into a revenue contract with a customer for the purchase of goods or services while negotiating a share-based sales incentive with that customer. If a grant date has not been established for that award because the terms are still being negotiated, the entity would be required to estimate the fair-value-based measure of the award and reflect that estimate (or a portion of the estimate) as a reduction of the transaction price. That estimate will be adjusted in each reporting period until a grant date has been established.

Classification

As discussed above, the classification of share-based sales incentives is subject to the guidance in ASC 718. Therefore, an entity applies ASC 718-10-25-6 through 25-19A to determine whether an award is classified as equity or a liability. As in the case of other nonemployee awards, if (1) the award is subsequently modified when vested and (2) the grantee is no longer a customer, the award becomes subject to other U.S. GAAP (e.g., ASC 480, ASC 815) unless the modification is made in conjunction with an equity restructuring that meets certain conditions.

Subsequent Measurement and Presentation

Under ASU 2019-08, share-based sales incentives are measured on the grant date (for both equity-classified and liability-classified share-based payments) in accordance with the guidance in ASC 718. In addition, under ASC 718, equity-classified awards are not remeasured, whereas liability-classified awards are remeasured until settlement.

Further, since both vesting and nonvesting conditions should be evaluated under ASC 718, a change in the probable or actual outcome of a service or performance condition that results in a change in the measurement of the award should be reflected as a change in the transaction price. If an estimate is required, an entity should estimate the total fair-value-based measure of the sales incentive (e.g., by determining the number of equity instruments that it will be obligated to issue) and update that amount until the award ultimately vests or is forfeited.

By contrast, any changes in measurement that are due to the form of consideration are not reflected as changes to the transaction price but instead are presented elsewhere in the income statement. This includes changes to the fair-value-based measure of liability-classified awards that are not related to service or performance conditions. If such changes are not due to the form of consideration (i.e., changes in the probable or actual outcome of a service or performance condition), they are reflected as changes to the transaction price on the basis of the awards’ grant-date fair-value-based measure.

Connecting the Dots

While the ASU states in ASC 606-10-32-25A that subsequent changes in measurement due to the form of the consideration should not be included in the transaction price (i.e., should not be presented as an adjustment to revenue), it does not specify where such changes should be reflected in the income statement. Therefore, an entity would use judgment to determine the appropriate presentation in such circumstances.

Equity-Classified Share-Based Payments

ASC 718 requires that entities measure equity-classified share-based payment awards on the grant date and not remeasure them unless the awards are modified. Entities should determine the grant-date fair-value-based measure of the award on the basis of the probable or actual outcomes of any service or performance conditions (whether vesting or nonvesting). The probable or actual outcomes are reassessed in each reporting period, and the final measurement of the award associated with the ultimate outcomes of those conditions will be reflected as a reduction of the transaction price. Therefore, any changes to the total measurement of a share-based sales incentive would not be attributable to the form of consideration and should be recognized as a change to the transaction price.

Liability-Classified Share-Based Payments

Under ASC 718, liability-classified share-based payment awards must be remeasured at the end of each reporting period until settlement. However, ASU 2019-08 requires that entities reflect only the grant-date fair-value-based measure of a liability-classified share-based sales incentive as a reduction of revenue in accordance with ASC 606. Any changes to the measurement of the share-based sales incentive after the grant date that are attributable to the form of the consideration (i.e., not due to the probable or actual outcome of any service or performance conditions) would be reflected elsewhere in the income statement. Therefore, although entities would be required to remeasure liability-classified share-based sales incentives at the end of each reporting period until settlement, they would not reflect as an adjustment to revenue subsequent changes to the fair-value-based measure that are attributable to the form of the consideration.

Connecting the Dots

Under ASC 718, a nonpublic entity is permitted to use a practical expedient to measure all liability-classified share-based payment awards at intrinsic value instead of a fair-value-based measure. This practical expedient must be applied consistently to both employee and nonemployee awards. However, under the ASU, a nonpublic entity’s initial and subsequent measurement of its liability-classified share-based sales incentives should be calculated at the fair-value-based measure even when the entity makes the intrinsic value measurement election for other liability-classified awards within the scope of ASC 718.

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